The Strength of Corporate Culture and the Reliability of Firm Performance

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Much popular and scholarly attention has been focused on the hypothesis that strong cultures, defined as "a set of norms and values that are widely shared and strongly held throughout the organization" (O'Reilly and Chatman, 1996: 166), enhance firm performance. This hypothesis is based on the intuitively powerful idea that organizations benefit from having highly motivated employees dedicated to common goals (e.g., Peters and Waterman, 1982; Deal and Kennedy, 1982; Kotter and Heskett, 1992). In particular, the performance benefits of a strong corporate culture are thought to derive from three consequences of having widely shared and strongly held norms and values: enhanced coordination and control within the firm, improved goal alignment between the firm and its members, and increased employee effort. In support of this argument, quantitative analyses have shown that firms with strong cultures outperform firms with weak cultures (Kotter and Heskett, 1992; Gordon and DiTomaso, 1992; Burt et al., 1994).

The existing literature on the relationship between culture strength and performance focuses on the consequences of strong cultures for performance levels but has not examined how strong cultures affect performance variability, or the reliability of firm performance. This is surprising, since the arguments relating culture strength to performance draw particular attention to the benefits of having greater internal consistency in goals and behaviors. One should therefore expect strong-culture firms to exhibit less variable performance. This expectation is complicated, however, by the fact that the variability of a firm's performance depends not only on the ability to maintain consistency in internal processes but also on the firm's ability to adapt to environmental change. The relationship between culture strength and performance reliability, therefore, should depend on how strong-culture firms learn from and respond to both their own experiences and changes in their environment. Incremental adjustments to org anizational routines should be easier in strong-culture firms, because participants have an agreed upon framework for interpreting environmental feedback and a common set of routines for responding to different signals from the environment. In relatively stable environments, firms with strong corporate cultures should therefore have less variable performance than firms with weak corporate cultures, in addition to performing at a higher average level.

In more volatile environments, however, incremental adjustments to organizational routines may not be sufficient. This suggests that the variance-reducing benefits of strong cultures may attenuate as environmental volatility increases and may help explain why some strong-culture firms have encountered great difficulties in responding to changes in their environment (Carroll, 1993; Tushman and O'Reilly, 1997).

Studying the relationship between culture strength and performance variability therefore has the potential to shed light on the ability of strong-culture firms to adapt to change. Performance variability is also an important outcome in its own right, because it plays a central role in a variety of theoretical approaches to organizations. Behavioral theories of the firm suggest that risk taking by managers depends on firm performance relative to aspiration levels (Cyert and March, 1963; Bromiley, 1991); highly variable performance may increase the frequency of risk-taking behavior. Similarly, while organizations may attempt to buffer themselves from environmental variability in order to facilitate planning and decision making (Thompson, 1967) and increase organizational autonomy (Pfeffer and Salancik, 1978), this may be more difficult when performance is highly variable. Organizational ecologists have attributed causal importance to performance variability by arguing that external stakeholders typically attach value to predictable performance, giving reliable firms a survival advantage (Hannan and Freeman, 1984). For example, suppliers will generally prefer customers that generate predictable orders and reliably pay on time, and many employees value stable employment prospects. Investors should generally prefer to have less temporal variability in performance for a given return (Bodie, Kane, and Marcus, 1996). Performance variability also affects the chances of failure directly: a simple random-walk model of the accumulation and depletion of organizational resources suggests that for a given stock of resources, firms with more variable performance are more likely to exhaust their resources and fail (Levinthal, 1991 a).

While these arguments from organizational theory suggest the importance of variability in overall firm performance, theory and evidence in corporate finance suggest that variability in specific aspects of firm performance affect organizational behavior. For example, firms with highly variable cash flows find themselves at a competitive disadvantage, for two reasons. First, highly variable cash flows imply that there will be periods when a firm will underinvest in worthwhile projects. Some projects that are attractive when there is sufficient internal capital will be unattractive during periods of internal cash-flow shortfall, if external capital is more expensive than internal capital. This is one reason why firms may wish to engage in risk-management activities, such as hedging (Lessard, 1990; Froot, Scharfstein, and Stein, 1993). Second, firms with more variable cash flows have higher costs of external capital than firms with more stable cash flows, which means that fewer projects will be attractive (from a capital budgeting perspective) in firms with variable performance. The increased cost of capital derives in part from greater information asymmetry in the external capital market, because firms with highly variable cash flows are less likely to be followed by market analysts. Empirically, Minton and Schrand (1999) found that firms with highly variable cash flows have lower levels of capital investment, lower levels of analyst following, lower Standard & Poor's bond ratings, and higher weighted average costs of capital. Thus, if strong corporate cultures lower performance variability, strong-culture firms are less likely to suffer from underinvestment.

For all of these reasons, corporate culture strength has implications for organizational outcomes that go beyond their effects on mean performance levels. In this paper, I expand on the relationship between the strength of corporate culture, organizational learning processes, and firm performance and analyze the implications of this relationship for reliable performance by explicitly modeling the temporal variance in firm performance as a function of the strength of corporate culture in a sample of large, publicly held firms.

THE STRENGTH OF CORPORATE CULTURES AND FIRM PERFORMANCE

Interest in the concept of organizational culture has exploded in the past two decades. Researchers have approached the topic with a wide array of theoretical interests, methodological tools, and definitions of the concept itself. Debate over fundamental issues of theory and epistemology is intense (Martin, 1992; Trice and Beyer, 1993). While some see attempts to measure organizational cultures and their effects on organizations as highly problematic (e.g., Siehl and Martin, 1990; Martin, 1992; Alvesson, 1993), a large body of research starts from the assumption that culture is a measurable characteristic of organizations (O'Reilly and Chatman, 1996). These studies do not seek to interpret the meaning of different organizational cultures or cultural forms per se but, rather, focus on their consequences for organizational behavior and processes. Studies of the effects of strong corporate cultures for firm performance, including this paper, fall within this tradition. I adopt O'Reilly and Chatman's (1996:160) d efinition of organizational culture as "a system of shared values (that define what is important) and norms that define appropriate attitudes and behaviors for organizational members (how to feel and behave)" (for similar definitions, see Rousseau, 1990; Kotter and Heskett, 1992; Gordon and DiTomaso, 1992). Moreover, a culture can be considered strong if those norms and values are widely shared and intensely held throughout the organization (O'Reilly and Chatman, 1996: 166; O'Reilly, 1989; Gordon and DiTomaso, 1992; Kotter and Heskett, 1992). This definition of culture strength, in contrast to some others, entails no assumptions about which values and norms might enhance organizational performance (e.g., Ouchi, 1981; Deal and Kennedy, 1982; Denison, 1990).

One of the key consequences of a strong corporate culture is that it increases behavioral consistency across individuals in a firm. Organizational culture defines a normative order that serves as a source of consistent behavior within the organization. In this sense, organizational culture is a social control mechanism (O'Reilly, 1989; O'Reilly and Chatman, 1996). At the same time, organizational cultures frame people's interpretations of organizational events and basic assumptions about organizational processes. Schein (1991: 15) emphasized that organizational cultures "provide group members with a way of giving meaning to their daily lives, setting guidelines and rules for how to behave, and, most important, reducing and containing the anxiety of dealing with an unpredictable and uncertain environment." Widespread agreement about basic assumptions and values in the firm should increase behavioral consistency (Gordon and DiTomaso, 1992) and thereby enhance organizational performance, which is a function of t he potential return to an organization's activities and its ability to carry out those activities. The impact of consistency on execution is important, since firms with excellent strategies (high potential return) may perform poorly if they fail to execute well, and firms that execute their routines extremely well may compensate for suboptimal strategies.

While it is possible that strong-culture firms may be better (or worse) at choosing appropriate strategies, theories of the culture effect focus on the positive impact a strong culture has on the execution of routines. Theorists have put forward three interrelated explanations for the performance benefits of strong cultures (Kotter and Heskett, 1992). First, widespread consensus and endorsement of organizational values and norms facilitates social control within the firm. When there is broad agreement that certain behaviors are more appropriate than others, violations of behavioral norms may be detected and corrected faster. Corrective actions are more likely to come from other employees, regardless of their place in the formal hierarchy. Informal social control is therefore likely to be more effective and cost less than formal control structures (O'Reilly and Chatman, 1996). Second, strong corporate cultures enhance goal alignment. With clarity about corporate goals and practices, employees face less uncerta inty about the proper course of action when faced with unexpected situations and can react appropriately. Goal alignment also facilitates coordination, as there is less room for debate between different parties about the firm's best interests (Kreps, 1990; Cremer, 1993; Hermalin, 2001). Finally, strong cultures can enhance employees' motivation and performance because they perceive that their actions are freely chosen (O'Reilly, 1989; O'Reilly and Chatman, 1996).

Early studies reported mixed evidence of a positive relationship between culture strength and performance (Siehl and Martin, 1990) but generally defined culture strength in terms of the content of organizational values and norms. …

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